Dennis was clear that it would take stick-to-itiveness to follow the rules day to day and do it right: “To follow the good principles and not let fear, greed and hope interfere with your trading is tough. You’re swimming upstream against human nature.”19 The Turtles had to have the confidence to follow through on all rules and pull the trigger when they were supposed to. Hesitate and they would be toast in the zero-sum market game.
This motley crew of novices quickly learned that of the five questions deemed to be most important by Eckhardt, the first two, about the market’s state and the market’s volatility, were the objective pieces of the puzzle. Those were simply facts that everyone could see plain as day.
Eckhardt was most interested in the last three questions, which addressed the equity level, the systems, and the risk aversion. They were subjective questions all grounded in the present. It did not make a difference what the answers to these three questions were a month ago or last week. Only “right now” was important.20
Put another way, the Turtles could control only how much money they had now, how they decided to enter and exit a trade now, and how much to risk on each trade right now. For example, if Google is trading at 500 today, Google is trading at 500. That’s a statement of fact. If Google has a precise volatility (“N”) today of four, that’s not a judgment call.
To reinforce the need for objectivity on issues such as “N” Eckhardt wanted the Turtles to think in terms of “memory-less trading.” He told them, “You shouldn’t care about how you got to the current state but rather about what you should do now. A trader who trades differentially because of swings in confidence is focusing on his or her own past rather than on current realities.”21
If five years ago you had $100,000 and today you have only $50,000, you can’t sit around and make decisions based on the hypothetical $100,000 you used to have. You have to base your decisions on the reality of the $50,000 you have now.
How to handle profits properly is a separation point between winners and losers. Great traders adjust their trading to the money they have at any one time.
If crude oil had just traded above $40 for the first time, the Turtles were not to sit around and kibitz about it. They were to take action if it hit their S1 or S2 entry or exit signals. Why or how it got to $40 was irrelevant. Eckhardt threw out the examples fast and furious.
He started with a commonplace idea that most people are willing to accept. If you make some profits with your original money, you can take more risks, because now you’re playing with their money. He said, “It’s certainly a comforting thought. It certainly can’t be as bad to lose their money as yours. Can’t it? Why should it matter whom the money used to belong to? What matters is whom it belongs to now (you) and what to do about it now.”22
For instance, assume you start with a $100,000 account, quickly making another $100,000. You now have $200,000. Although you made a profit, you can’t say, “I can now take crazier risks with that $100,000.”
Why would you view your money as funny money or lucky money? The Turtles were taught to treat that additional $100,000 as they did their original $100,000. They had to use the same concern, care, and discipline. The five questions didn’t change, even if their account balances did.
Traders who face the same opportunity must trade the same. Personal feelings can’t interfere.
Pretend there are two traders, John and Mary. John and Mary are exactly alike in all respects. They have the same risk aversion and the same system. There is one small difference between the two: John has 50 percent more money. John then decides to go on vacation and while he’s away having fun at South Beach, Mary makes 50 percent. Now they have exactly the same amount of money. How or why they got to the point of having the same amount of money is not relevant. The correct course for John is the correct course for Mary.23
Eckhardt did not want the Turtles to say. “I had a period where I made some money, so now I can do something different.” They had to take the same steps regardless.
Logically, upon first hearing that Mary had just made 50 percent more, most people might want to debate Eckhardt’s contention that they should trade the same way. The rule was designed to keep traders with a big profit run-up in their trading account from acting irrationally or breaking a rule. Many people with a big profit run-up don’t want to lose those paper gains. They are anxious to take their profits off the table so they can feel secure.
Eckhardt slammed home the point that the security craved by humans was bad for proper trading: “The distinction between open trade equity and closed-out trading profits is completely vacuous. How much do you have in open trade equity? How much do you have in closed-out equity? This is a bookkeeper’s artifact. It has absolutely no relevance to correct trading.”
While it might have zero relevance, people go the wrong way all the time. Instead of trading as they should today, based on their money now and their rules, they trade based on the money they once had. They are clearly trying to recoup. “How much money you use to have has no significance. It’s how much money you have now,” implored Eckhardt.24
If the Turtles started with $100,000 but now had $90,000, they still had to make trading decisions based on what they had now. If the Turtles were supposed to risk 2 percent of their trading capital, then they had to risk 2 percent of their current $90,000, not 2 percent of their original $100,000.
If the Turtles lost money in a market, they had to move on. Accepting and managing losses are part of their game.
The whole notion of holding on to the past was a big issue for the team at C&D Commodities. Eckhardt was stern about the mistake losing traders make when they look backward in time. The losing trader is trying to make money back in the same market and on the same position. Eckhardt described it as a “market vendetta.”
Suppose John lost money in Cisco. That market “hurt” him. Instead of focusing on what the best opportunity might be now, he only wants his money back in Cisco. All John can think about is his Cisco position, and in turn his loss just keeps growing. According to Eckhardt, this is the kind of personal memory mistake that always leads to disaster.25
The Turtles were taught not to fixate on what particular market made money that month or year or what market lost money. They learned to be agnostic and accept whatever trending market created opportunity.
The same principle was seen with “losses.” For example, when the Turtles were taught that they had to exit with a small loss, because they don’t know how far it could drop, they got out. What they didn’t want to do was look at the initial small loss and say, “I had $100,000 of Microsoft and now I have $90,000, so I’m going to put another $10,000 of my money into MSFT because now it’s cheap.”
Dennis said that to add to a losing position was like being the kid who’s been burned on a hot stove once already but puts his hand back on the stove just to prove it was the stove that was wrong.26 However, that said, if after taking a small loss the Turtles got a signal to get into the market again, they got back in. An example using legendary hedge-fund manager Paul Tudor Jones best explains the point.
In one of Jones’s best trades, he got an entry signal. He got in. The trade went against him and he lost 2 percent, forcing him to get out. All of a sudden, the entry signal came right back as the market moved in his favor again. He could not debate it. He had to get back in. Then it went against him again for another 2 percent loss, forcing him to get out again. He went through this process ten or so times in a row until he got a position that actually kept trending. That final big trend made enough money to pay for all those false starts and then some, but to get there in the first place he had to follow his rules religiously.
The same lesson is seen in sports. Even though Larry Bird was one of the best basketball three-point shooters ever, he wasn’t perfect. Let’s say on an average he hit 40 percent of his three-point shots. But if all of a sudden he went on a streak where he missed fifteen in a row, what did that mean? Could Bird afford to stop
taking three-point shots? No. That was what Dennis and Eckhardt were teaching.
Another great example of the statistical mindset Dennis and Eckhardt were teaching the Turtles can be found in baseball. Assume you bat .300 for ten years straight. All of a sudden you go 0 for 25. Does that mean you are no longer a .300 batter? No. It means you still have to go up to the plate and swing like you’ve always swung, because that’s the discipline of being a .300 hitter. The Turtles played the odds for the long haul.
The Turtles were taught not to fixate on when they entered a market. They were taught to worry about when they will exit.
Pretend again there are two traders, John and Mary. They are exactly the same except in the amount of trading capital each of them has. Assume John has 10 percent less money, but enters a trade before Mary. By the time Mary gets in her trade, they both have the same amount of money. Eckhardt clarified, “What this means is that once an initiation is made, it should not matter at all to subsequent decisions what the initiation price was.” He wanted the Turtles to literally trade as though they didn’t know what their entry price was.27
Dennis kept bringing his teachings back to losses “The trader who is averse to losses is in the wrong business.”28 The “secret” was what he did with the wrong positions, not with the right ones.29 Managing the losing trades (what Dennis called the “wrong positions”) allowed traders to wait for the right ones (big trends). This is why the entry price was only so important.
What Dennis and Eckhardt were teaching was the exact opposite of Warren Buffett’s buying “value.” The Turtles were supposed to say, “I want to buy or sell short markets that are in motion, moving up or down, because markets in motion tend to stay in motion.” If markets are moving higher, that’s a good thing. If markets are moving lower, that’s a good thing, too. Dennis and Eckhardt wanted the Turtles to profit from both.
Dennis was pushing his students go against basic human nature. He said, “The single hardest thing I have to do to make people understand how I trade is to convince them how wrong I can be about things, how much of a guess it is. They think that there’s some magic involved and that it’s not just trial and error.”30
C&D’s trading inspired a great deal of mystification, but in reality they were a mass merchandiser who sold 90 percent of their products as loss leaders so they could make a gigantic profit on the remaining 10 percent. Sometimes they had to wait a long time for good things to happen. Most people can’t psychologically handle the wait.31
Look at this logic from a media company perspective. Like Dennis and Eckhardt, movie producers and publishing executives know they will have “losers.” A movie studio will fund ten movies. A book publisher will fund ten books. In both cases, the producers or publishers often have no idea which one exactly of the ten is going be successful. In fact, they might be lucky if one of the ten is successful. Since they don’t know which one is going be successful, they still have to fund all ten. If nine of those books aren’t successful, well, the publisher is only going to print a small batch to begin with—that equals a small loss. If those movies or books don’t do well, fine. They’re done. The companies cut their losses and get out. However, the movie or book that does really well, the tenth one, pays for the losses from the nine losers.
The Turtles were taught to think of themselves as the publisher, the movie studio, or the casino “house.”
Don’t try to predict how long a trend either up or down will last. It is impossible.
Eckhardt gave the Turtles an example of a market moving rapidly through the point where they were supposed to buy, but for whatever reason had missed. Now they are sitting there waiting for a “retracement.” While they wait for the cheap place to buy, the market keeps racing higher and higher. Eckhardt said there was “a great temptation to reason that now it’s too high to buy. If you buy it now you’ll have an initiation price that’s too high. However, it is imperative that you make this trade. The initiation price simply won’t have the kind of significance you suppose it will have after the trade is made.”32
The Turtles were not to wait for a retracement. There was no statistical justification to think like that. If they were trading soybeans at $8.00 and they went to $9.00, the Turtles were taught to buy them at $9.00 rather than wait for them to retrace to $8.00. They might never retrace to $8.00.33
How would the Turtles have acted if they’d received a buy signal for Google for the first time at $500? They would buy. Get on board now was the thinking. Dennis always came back to the scientific method, saying that when you have a position, you put it on for a reason and you’ve got to keep it on until the reason no longer exists: “You have to have a strategy to trade, know how it works and follow through on it.”34
There is a flip side to this mentality, however. For example, on Wednesday, November 22, 2006, Google opened the day at over $510 a share. Within five days, by Wednesday the 29th, Google was trading at $483, which means Google had pulled back nearly thirty points. When it got to $510, could you know it was going to keep going up or that it was going to go down? You couldn’t know either way. What could you do? All you could do was let the price tell you what to do.
Eckhardt was teaching math and rules to manage the emotions felt in the face of uncertainty. He said, “Are you involved in emotional personal memories as opposed to objective knowledge? What I’m advising against is letting factors that are personal, emotional and idiosyncratic to your own history influence your trading.”35
Measuring volatility was critical for the Turtles. Most people then and today ignore it in their trading.
The question Dennis and Eckhardt always asked was, “How big should you trade based on current volatility?” In other words it’s not so much the current price of a given stock or futures contract that is paramount, but rather knowing at all times the market’s volatility.36 For example, it’s important to know that Microsoft is at a price level of 40 today, but it’s even more important to know Microsoft’s volatility (“N”) now so you can buy or sell short the right amount of Microsoft based on your limited capital.
Near the end of the breakneck training, Dennis and Eckhardt reiterated the obvious to their newly trained Turtles. The successful students in the class would be the ones who followed the rules and did not deviate. They did not want creative geniuses; It must have been ego-deflating for Turtles once they realized, what Dennis and Eckhardt were looking for was the equivalent of robots.
Investor Bradley Rotter, who has been called the very first investor with Dennis, saw their conundrum:
Applaud the genius of Richard Dennis. The program was well put together. It was focused on discipline. It didn’t matter if a trade felt good or felt bad, they had to just [do it]. It was a very, a very simplistic trend following system that had an aggressive matrix to add to winning positions and subtract from losing positions and all those people who are very successful are those who just followed the formula and did not deviate.37
Note: For some readers, chapter 4 will be the only chapter on the Turtle philosophy and rules worth examining. This book has been designed in such a way that you can continue and dive into the “math” that makes up the exact Turtle trading rules in chapter 5, while the casual reader can jump ahead to chapter 6 without skipping a beat.
For those interested in reading chapter 5, the following basic Wall Street terms from Wikipedia.com should be assumed:
Long: One who has bought futures contracts or owns a cash commodity.
Short (noun): One who has sold futures contracts or plans to purchase a cash commodity.
Short (verb): To sell futures contracts or initiate a cash-forward contract sale without offsetting a particular market position. Short selling or “shorting” is a way to profit from the decline in price of a security, such as a stock or a bond. Most investors “go long” on an investment, hoping that price will rise. To profit from the stock price going down, a short seller can borrow a security and sell it, expecting that it will decrease i
n value so that he can buy it back at a lower price and keep the difference.
Volatility: A measurement of the change in price over a given period.
Futures contract: A standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. The future date is called the delivery date or final settlement date. The pre-set price is called the futures price. The price of the underlying asset on the delivery date is called the settlement price. The settlement price normally converges toward the futures price on the delivery date. Both parties of a futures contract must fulfill the contract on the settlement date. The seller delivers the commodity to the buyer, or, if it is a cash-settled future, then cash is transferred from the futures trader who sustained a loss to the one who made a profit. To exit the commitment prior to the settlement date, the holder of a futures position has to offset his position by either selling a long position or buying back a short position, effectively closing out the futures position and its contract obligations. Futures contracts, or simply futures, are exchange-traded derivatives.
Market order: A buy or sell order to be executed by the broker immediately at current market prices. As long as there are willing sellers and buyers, a market order will be filled.
Stop order (sometimes known as a stop loss order): The complement of a limit order. It is an order to buy (or sell) a security once the price of the security has climbed above (or dropped below) a specified price, known as the stop price. When the specified price is reached, the stop order is entered as a market order.
The Complete TurtleTrader Page 8
